On June 19th during a press conference following a normal FOMC policy statement, Bernanke made a vague and familiar reference to the fact that the Fed will ease back on its quantitative easing program in the event that economic data improves.
Bernanke never actually said he planned to taper. He never even used the word. Regardless, the bond market went nuts sending the stock market into a borderline panic. In five days rates on the 10-year Treasury rose some 20% and the S&P 500 dropped almost 100 points on an intraday basis.
Since then rates have stayed relatively elevated, but equities stormed back and stocks have made new record highs.
Zachary Karabell of River Twice Research says he doesn't expect Bernanke to change his tune this week but it wouldn't shock him to see the markets once again storm all over the place like headless chickens.
Without so much as a spoiler alert Karabell lays out what the Fed's message will be on Wednesday and Thursday: "As economic conditions improve the Fed will observe and consider ending its $85 billion in purchases a month with rates staying low."
Just because everyone knows what's going to be said doesn't mean it's easy to forecast the reaction; a cause and effect that says more about the nature of bond market participants than it does about FOMC planning.
"There's a lot of money in the bond market that thinks it's safe," Karabell explains.
Yields on the 10-year (^TXN) moving from 1.63% on May 2nd to 2.56% currently disabused traders of that notion. Bonds are still crowded on the long side but so are equities. When so much new money is sloshing out of cash and into relatively unfamiliar assets the marginal buyer or seller is what traders refer to as "weak hands," meaning they're apt to create their own volatility as the flood in and out of positions at any price based on what they think they hear Bernanke say.
Whether it's high frequency trading algorithms or frenetic players in the bond market, institutional money is starting momentum moves like we saw in late June. The hyper tension is a function of a circular logic that's hard to debunk. If someone thinks the only reason markets are strong is because of Central Bank planning it stands to reason that an end to QE will result in a collapse in asset prices.
"It's got this perfect hermetically sealed argument that it will happen and it will get bad," Karabell says of the theory that less stimulus equals collapsing prices. "I don't think that's true but, hey, we'll all find out soon enough."
It's impossible to debunk future logic. If the last five years of economic experimentation has taught us anything it's that there's a yawning chasm between what economists think they know and the way things work outside the lab where financial decisions are made.
What we know from the recent past is this: it's been a huge mistake for most investors to play the game of buying or selling based on their interpretation of what Bernanke says.
We've said it before on Breakout and we'll probably be forced to say it again later this week: Stop trading off taper talk! The only people that stand to gain from such capricious moves are your brokers and investors on the other side of your trades.